CSX (NYSE:CSX) reported dismal first quarter results, which does not come as unexpected news. A continuation of adverse trends have been weighing on the results, including a further acceleration of coal volume declines. This headwind and the ¨industrial recession¨ have been too much to overcome.
If you strip out the impact of lower fuel surcharges and the secular declines in coal, the underlying trends look more upbeat. Strong pricing, stable volumes and impressive cost containment are reasons to be upbeat. The strong operational performance, in a difficult operating environment, make sure that shares offer decent value at current levels.
Terrible Headline Results
Top line sales fell by 13.5% towards $2.62 billion, as those percentage declines look very worrying. The actual results are not as bad as they might appear, as CSX no longer benefited from $95 million in minimum volume commitments, which it did receive in the first quarter of last year. The other headwind was caused by a $139 million reduction in fuel surcharge revenues, which totaled just $52 million this quarter. If not for these two items, revenues fell by just 5.8%.
These declines are mostly explained by a 5% drop in volumes as 3.1% pricing gains have been offset by adverse mix effects. The key driver of this mix effect is a continuation of growth in low-yielding intermodal carloads, while lucrative coal volumes are plunging.
Actual coal carload volumes fell by 31% to 200k during the quarter. If not for the decline in coal volumes, overall company-wide volumes were flat or even up slightly, mostly resulting from growth in intermodal and automotive transportation.
The coal business remains a continued headache for executives in the industry. There is some sparse good news as well. Following the declines, the share of coal volumes has dropped towards 13% of total volumes being transported by CSX. Management furthermore said on the conference call that it sees a full year drop in coal volumes of 25%. This suggests that the situation might be stabilizing, although comparables become easier as well.
Impressive Cost Containment
It is hard to keep margins stable in an environment in which sales plunge by 14% and volumes are down by 5%. Overall costs were down by 12% and that is quite impressive for a capital-intensive business. A 44% reduction in the fuel bill has been helpful, reducing actual fuel costs by $120 million. This reduction is actually less than the $139 million decline in fuel surcharge revenues, creating a small headwind versus the year before.
The company has been very good at containing labor costs as well as materials and supplies related costs. Labor inflation has been tackled by reducing the headcount by 4,500, or by 14% in total headcount numbers. This is a very impressive achievement but has somewhat been offset by reasonable wage inflation, with costs per worker going up by 4%.
These cost containment efforts are offset by a 6% increase in depreciation costs to $313 million. This is no surprise as the long-term nature of the network assets creates a natural tendency for depreciation charges to increase overnight. Years of cumulative inflation makes that capital expenditures almost always exceed depreciation charges, even to just maintain the network.
The strong cost containment efforts resulted in a mere 90 basis-point reduction in operating margins. The modest fall in margins, towards 26.9% of sales, in combination with the plunge in sales, has hurt earnings quite a bit. These two items, as well as a modest increase in interest expenses, resulted in a 20% plunge in earnings. Net earnings fell towards $356 million, translating into an $0.08 reduction in earnings per share, which has fallen to $0.37 per share.
If you exclude the continued decline in coal, volumes were essentially flat. That is an encouraging sign, although headwinds from coal are expected to last for many years to come. If you believe that the first quarter might be representative for the rest of the year, CSX has the capacity to earn $1.50 per share, in what is a difficult operating environment.
With shares now trading at $25 per share, the multiple comes in at 16-17 times earnings, translating into a 6% earnings yield. This earnings yield is roughly 4% higher than the ten-year bond, as the dividend yield of roughly 3%, exceeds ¨risk-free¨ rates by a percent as well.
A Decent Value Play
CSX is a long-term play on the US economy, similar to Warren Buffett calling the purchase of Burlington Northern as a ¨Bet on America,¨
The company has seen real headwinds in 2015 and into 2016 and now supports a 6% earnings yield. Despite the fact that profits are down by a fifth compared to last year, the earnings yield has increased as shares have fallen by a third from the highs in early 2015. This indicates that valuation multiples have come down. This is an important sign, as the volumes (ex-coal) appear to show real signs of stabilization.
This creates a scenario in which earnings can stabilize in the coming quarters, and potentially increase going forwards. This is certainly the case as oil prices have shown a decent rebound, while the dollar has lost some of its strength as well. The potential for a recovery, in combination with valuation multiple inflation, can result in real potential upside for the shares, certainly in this low interest rate environment. This is certainly the case as railroads have already enjoyed strong pricing power. Despite the 5% drop in overall volumes, CSX managed to raise prices by more than 3% compared to last year.
While M&A might not be likely, continued rumors could support the shares, which offer decent value on their own. The attractive earnings yield, real opportunities for a stabilization at current levels, and long-term objectives to grow operating margins to the mid-thirties, all act as tailwinds. While the coal headwind will not abate anytime soon, CSX has delivered on cost savings and productivity measures, making it a decent operator, even in difficult operating environments.
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I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.